TAX NEWS - June 2010

Tax cuts for wealthy?

BHeffernan1 asks:

How many jobs does a federal gov dollar buy? Provide optimistic (most efficient -- extending unemployment? building a smart power grid?), median and pessimistic (tax cuts for wealthy?).

For reasons Ezra has laid out in the past, it's best to focus not on job creation narrowly, but on the general economic impact of a policy. Policies that create jobs have other benefits (and costs) as well. If you're evaluating a proposal to pay workers to build a railroad, you want to know what the value of that railroad is, not just how many workers were hired.

If you're giving laid-off workers unemployment insurance, the point isn't just job creation, but also helping them pay rent. So if you want raw job estimates for different policies, see Moody's analysis of the cost per job of job tax credit proposals, or CAP's look (PDF) at the job creation potential of various clean-energy investments. But keep in mind they leave out important effects of various proposals.

We can get a better picture of the overall effectiveness of a stimulus method by looking at its contribution to GDP. The most recent numbers come from April's Senate testimony (PDF) from Mark Zandi of Moody's. Zandi calculated the change in GDP caused by a dollar spent on various stimulus policies. Here are the results, grouped from least effective to most effective. You might want to click on the graph to see the larger, and more readable, version.

The pattern is striking: Direct government spending -- through unemployment benefits, food stamps, work sharing or infrastructure spending -- top the list, giving you more than a dollar's worth of stimulus for a dollar's worth of spending, while cuts to taxes affecting businesses and upper-income individuals -- such as the corporate, dividend, capital gains and alternative minimum taxes -- give you less.

The reason there is clear: A tax cut that ends up with upper-income folks gets saved rather than spent, and a dollar saved doesn't stimulate the economy. That's why some tax breaks, such as the job tax credit and payroll tax holiday, are fairly effective, though still less so than direct spending. The problem, of course, is that the politics of tax breaks are easier than the politics of spending, even though the tax breaks are actually more expensive. But if the government wants the maximum stimulus at the minimum deficit cost, direct spending is the way to go.